The Legit Ledger Podcast Ep. 13
NFT Insider Trading - Recent Enforcement, Rulings and Why You Need an Insider Trading Policy
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Listen to the original podcast released November 18, 2022 here:
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In this episode of The Legit Ledger, Sheppard Mullin attorneys Jim Gatto and Brittany Walter join host Yasamin Parsafar to discuss the latest developments in the federal government's insider trading case against Nathanial Chastain, a former head of product at NFT marketplace OpenSea.
Guests:
About Yasamin Parsafar
Yasamin Parsafar is a partner with the Intellectual Property Practice Group in Sheppard Mullin's San Francisco office, where she serves as co-leader of the firm's Blockchain & Fintech team. Her practice focuses on protecting her clients' intellectual property rights through counseling, prosecution, enforcement and litigation. Yasamin leverages her litigation experience to strengthen and protect her clients' intellectual property, manage risks and position businesses to succeed in the event of a dispute. She frequently advises and protects brands venturing into Web3 on various issues related to non-fungible tokens, metaverses, games, online marketplaces and other platforms.
About Jim Gatto
Jim Gatto is a partner with the Intellectual Property Practice Group in Sheppard Mullin's Washington, D.C. office, where he co-leads the Blockchain & Fintech Team. His practice focuses on blockchain, interactive entertainment, digital art, AI and online gambling. He advises clients on IP strategies, development and publishing agreements, licensing and technology transaction agreements, and tech regulatory issues. Jim has been involved with blockchain since 2012 and has been recognized as a thought leader by leading organizations, including Best Lawyers in America 2021-2022; Cryptocurrency, Blockchain and Fintech Trailblazer, The National Law Journal, 2018; and Thought Leader on Blockchain & Cryptocurrencies, National Law Review, 2018.
About Brittany Walter
Brittany Walter is an associate in the Intellectual Property Practice Group in Sheppard Mullin's San Diego (Del Mar) office, where she serves as associate co-lead of the firm's Technology & Commercial Transactions Team and is an active member of the Blockchain Team, Advertising Team and the Privacy and Cybersecurity Team. Brittany's practice focuses on technology transactions and counseling involving intellectual property, advertising and data privacy. She has a special focus on blockchain-based products and services, including non-fungible tokens, metaverses, virtual worlds and games.
Transcript:
Yasamin Parsafar:
Hi friends. Welcome to another episode of The Legit Ledger. I'm Yasamin Parsafar, the co-leader of Sheppard Mullin's blockchain team. I want to thank you all for joining and ask that if you enjoy this content to please subscribe and share with your friends. We really appreciate that and it gives us motivation to continue to produce this content.
On today's episode, we're going to be discussing developments in the insider trading case against Nathaniel Chastain, the former employee of NFT marketplace OpenSea. We have published several blogs on this case and those will be linked in the show notes. Joining me today are co-leaders of Sheppard Mullin's blockchain team, Jim Gatto and Brittany Walter. Jim and Brittany, thanks so much for joining.
Jim Gatto:
Pleasure to be here, Yas.
Yasamin Parsafar:
So Brittany, can you give us an overview of the facts of the Chastain case and the charges that were brought against him?
Brittany Walter:
Sure. So the defendant, Nathaniel Chastain, was a product manager for OpenSea, which as you probably know is one of the largest marketplaces for crypto collectibles and non-fungible tokens or NFTs. In his role as product manager, he had responsibility for selecting which NFTs would be featured on the OpenSea home page. In bringing charges for both wire fraud and money laundering in connection with a scheme to commit insider trading in NFTs, the government generally alleged that Chastain used this information, that is which NFTs would be featured on the marketplace homepage, for his own personal financial gain.
The government's position was that when an NFT is featured on OpenSea's homepage, the value of the NFT and maybe other NFTs made by the same creator increased. Chastain had purchased dozens of NFTs shortly before they or other NFTs made by the same creator were featured on the homepage and then, after they were featured, sold them for profit. So the government alleged that he had misappropriated OpenSea's confidential business information and in doing so committed wire fraud. The government further alleged that in order to conceal his involvement in buying and selling the featured NFTs, Chastain transferred funds through anonymous Ethereum blockchain accounts and new Ethereum accounts without any prior history, and in doing so, committed money laundering.
What was interesting at the time the charges were filed against Chastain was that despite referring to this case as insider training, there was no allegation that the NFTs at issue were securities. And there was a lot of chatter in the NFT community regarding whether this activity can be deemed illegal if the NFTs were not in fact securities.
Yasamin Parsafar:
Thanks, Brittany. So recently Chastain filed a motion to dismiss, which the court ruled on, and that was one of the arguments that he made in the motion to dismiss, specifically that the government failed to allege essential elements of the wire fraud claim, including the existence of trading in securities or commodities. He alleged that even though this was referred to as an insider trading case, there was no allegation that the NFTs were securities or commodities. And the court ultimately rejected that argument. So, Jim, can you tell us a little bit about how the court decided that issue?
Jim Gatto:
Sure. So I think the short answer is they decided it pretty decisively. What the court said was that based on a prior case, the Carpenter case, which I'll touch on in a second, he said the Carpenter case actually dooms Chastain's argument, and went on to say that in fact the argument was wholly without merit. So the court didn't really hold back or say it was kind of a close issue from their perspective. And the precedent the court relied on, the Carpenter case as I mentioned, was an analogous case. It involved insider trading with wire fraud charges and in that case, just briefly, there was a reporter for the Wall Street Journal that did a column called Heard on the Street. And somewhat analogous to the situation here is they would write about up-and-coming stocks and typically when they published those articles, the stock would often move up in value.
The allegations in that case were that the reporter collaborated with a broker and was passing information on about the stocks that they were going to be writing about and when those publications would occur, and that the broker traded on those stocks and made hundreds of thousands of dollars. And in that case, which ultimately went to the Supreme Court, the part of the decision in that case made it clear that there didn't have to be securities. There was two charges, and one was a securities-related charge and the other was just kind of mail and wire fraud charges. And one of the kind of takeaways from that case is that the mail and wire fraud charges didn't have to even be a security.
So on the basis of that case and other precedent that the court in the Chastain case said that wire fraud, you'll get the elements of a wire fraud charge. It doesn't require that there be a security. I think a lot of the kind of confusion that people have is that when we typically hear about insider trading cases, people automatically think about insider trading under the securities laws, because that's probably the most well-popularized and most common fact pattern that we see. But the court made very clear that it doesn't have to be a security.
Yasamin Parsafar:
Okay, thanks, Jim. So Chastain did make a couple of other arguments that the court signaled could potentially have some legs. So I want to talk about those arguments as well. One of them was that the government failed to allege another essential element of the wire fraud count, which is that the information that he allegedly misappropriated is not property within the meaning of the wire fraud statute. And that would be information about what NFTs were going to be featured on the marketplace. So can you tell us about what the court said about that issue?
Jim Gatto:
Yeah, so there's a couple of pieces to that argument. So the element of the test is whether the defendant created or participated in a scheme to defraud another out of money or property. And here Chastain tried to frame the argument that by buying NFTs from someone else, that wasn't property of his employer so he really wasn't defrauding the employer out of their property. And I think that the way the court looked at this was kind of more analogous to the Carpenter case where the stocks that were being traded weren't the stocks of Wall Street Journal in the Carpenter case, but rather in both of these cases, the courts found that what the property of the employer was, was the information about what they were going to publish on their site and when.
And so in the Carpenter case, they found that the information about the publication about different stocks was property even though it was intangible. And similarly in the Chastain case, the court found that the information about what NFTs were going to be published on the website was confidential information of OpenSea. And it's that information which constitutes property of the employer that was actually misappropriated by the defendant.
Yasamin Parsafar:
Okay. And then another argument that Chastain made with respect to the other count, the money laundering count, was that the government failed to sufficiently allege two elements of that crime, including the concealment element and the financial transaction element. So with respect to the concealment element, there was some discussion about the use of the Ethereum blockchain for those transactions. Can you tell us a little bit about what those arguments were?
Jim Gatto:
Sure. So the court didn't end up deciding this issue, with what they basically said was the government alleged enough in their pleadings to get past basically this motion to dismiss phase. So there wasn't a ruling on it. But what was alleged in the complaint against Chastain was that he did involve concealment by, as you alluded to, he was buying NFTs, he transferred funds through blockchain accounts. And the allegations are those are anonymous accounts, we'll come back to that in a second. But that he also created a number of new Ethereum accounts, ones that had no prior history, and apparently moved money from one account to another. And so the court looked at that and said that's at least enough of a pleading of concealment and the fact that there were financial transactions, of course, without ruling on the sufficiency of whether the government can prove those allegations and whether they're sufficient to meet the legal standard. But that's the gist of what the argument is.
But to come back to that and, look, I think this is going to be an interesting facet of the case moving forward, and I think this is really an interesting thing for the blockchain community. Some have said that if just using a blockchain account is concealment, then that's a pretty extreme position. I would be surprised if that argument by itself prevails. As we all know, the accounts are not anonymous, they're pseudonymous. So there's a wallet ID that you transact with, and in many cases, the government has enabled to track the wallet ID to a person through computer forensics.
Where I think this case gets interesting, and assuming the government's allegations are true, if in fact he didn't just use his existing account to do this, but he created new accounts with no prior history, you wonder why he did that. Was it to conceal something? Not deciding, and I'm just saying I think that's going to be pivotal to the government's argument is that by creating accounts with no prior history, it makes it a little bit harder perhaps to track the owner. And if in fact that's what he did and he moved it from one account to the other, it could be interesting to hear what the legitimate basis for doing that was if it wasn't to conceal funds.
Yasamin Parsafar:
Right. I think these issues are going to be really interesting to follow for the entire Web3 community and see how the court decides these novel issues. So, Brittany, one thing that I wanted to cover today, because the charges brought in this case are concerning for both marketplaces, platforms, and the employees who work there. And for our friends out there who are or who work at NFT marketplaces or other platforms that allow for the sale or trading of NFTs, what kind of practical advice or guidance can we give them going forward in order to protect themselves from these situations?
Brittany Walter:
Sure. So we recommend that all companies dealing with NFTs consider adopting an NFT trading policy because as this case demonstrates the liability for improper trading can arise even if the NFT is not deemed a security. This Chastain case is a great illustration why it's important for NFT marketplaces in particular to put one in place, but even players in the NFT space should consider one as well. For example, brands and IP owners who create their own NFTs.
And if you're thinking about a typical insider training policy, they also prohibit other sorts of conduct that have some analogous applicability in the NFT context as well, such as wash sales or other activities that are intended to artificially manipulate the price or volume of a NFT sale. And it's important for companies to think that even if some of this conduct isn't per se illegal, it certainly carries with it a great risk of reputational harm to the company or brand. The actual scope and content of the policy will vary depending on the nature of your business and the role you take with respect to NFTs. But one of the recent blog posts on this issue, which again, we've linked in the show notes, give some great examples of topics you should consider covering.
Yasamin Parsafar:
Thanks so much for that, Brittany. Jim, do you have anything else to add to that in terms of takeaways for our friends out there in the NFT world?
Jim Gatto:
Yeah, so I would reiterate what Brittany said about checking out the blog posts we did on insider trading policies for NFTs. There's a wide range of topics in there. I would also just add that this is not the only case that has been filed with respect to insider trading involving crypto assets. There was another one involving another marketplace that's kind of still pending. So I think that it's important, as Brittany said, depending on what your role is as an employer, you just like you have other policies and many companies have insider trading policies with respect to securities, you want to broaden that out and supplement those policies with a NFT trading policy. And it's not just insider information, it can be other activities as Brittany mentioned. So we think that as more companies get into this space and they're encountering issues that they haven't encountered before, it's important to think through what needs to be done to update existing policies and procedures and legal processes. And we've been touting this for a while, telling companies they should be doing these policies, and we're seeing more companies actually jump on the bandwagon and do that now.
Yasamin Parsafar:
Great. Thank you so much Jim and Brittany for joining us today and for your tips. That's it for this week's episode. If you have any topic suggestions or would like to be a guest on our show, please do not hesitate to reach out. Our contact information is linked below and if you have any Web3 legal needs, please do not hesitate to reach out to us today. We hope to hear from you all. Thank you and we'll see you next time.
Resources:
NFT Insider Trading Charge Doesn't Require the NFT To Be a Security
NFT Insider Trading – Can There Be A Crime If It's Not A Security?
Former NFT Marketplace Employee Charged with Insider Trading
NFT Insider Trading Compliance Policies – What They Cover and Why You Need One
Contact Information:
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